CHAPTER 11

Cost - Methods, Techniques of Cost Accounting

and Classification of Cost

I. METHODS OF COSTING
Meaning: The term 'methods' and 'systems' are used synonymously to indicate an integrated set of
procedures based on a complex concept of ideas, principles and concepts. The term method of costing
refers to cost ascertainment. Different methods of costing for different industries depend upon the
production activities and the nature of business. For these, costing methods can be grouped into two broad
categories: (1) Job costing and (2) Process costing.
(1) Job Costing
Job costing is also termed as Specific Order Costing (or) Terminal Costing. In job costing, costs are
collected and accumulated according to jobs, contracts, products or work orders. Each job is treated as a
separate entity for the purpose of costing. The material and labour costs are complied through the
respective abstracts and overheads are charged on predetermined basis to arrive at the total cost. Job
costing is used in printing, furniture making, ship building, etc.
Job costing is further classified into (a) Contract costing (b) Cost plus contract and (c) Batch costing
(a) Contract Costing: This method of costing is applicable where the job work is big like contract
work of building. Under this method, costs are collected according to each contract work. Contract costing
is also termed as Terminal Costing. The principles of job costing are applied in contract costing.
(b) Cost plus Contract: These contracts provide for the payment by the contracted of the actual cost
of manufacture plus a stipulated profit. The profit to be added to the cost. It may be a fixed amount or it
may be a stipulated percentage of cost. These contracts are generally entered into when at the time of
undertaking of a work, it is not possible to estimate its cost with reasonable accuracy due to unstable
condition of material, labour etc. or when the work is spread over a long period of time and prices of
materials, rates of labour etc. are liable to fluctuate.
(c) Batch Costing: In Batch Costing, a lot of similar units which comprise the batch may be used as
a cost unit for ascertainment of cost. Separate Cost Sheet is maintained for each batch by assigning a batch
306 A Textbook of Financial Cost and Management Accounting

number. Cost per unit of product is determined by dividing the total cost of a batch by the number of units
of the batch. Batch Costing is used in drug industries, ready-made garments industries, electronic
components manufacturing, T V Sets, etc.
(2) Process Costing
This costing method refers to continuous operation or continuous process costing. Process costing
method is applicable where goods or services pass through different processes to be converted into
finished goods. Process costing is used in Cement industries, Sugar industries, Textiles, Chemical
industries etc.
The following are the important variants of process costing system:
(a) Operation Costing: It is concerned with the determination of the cost of each operation rather
than process. It offers scope for computation of unit operation cost at the end of each operation by dividing
the total operation cost by total output of units.
(b) Operating Costing: Operating costing is also termed as service costing. Operating costing is
similar to process costing and is used in service industries. This method of costing is suitable for concerns
rendering services. For example, Hospitals, Transport, Canteen, Hotels, etc.
(c) Output Costing: Output costing is also called Unit Costing (or) Single Costing. This method of
costing is applicable where a concern undertakes mass and continuous production of single unit or two or
three types of similar products or different grades of the same products. Under this method cost per unit is
measured by dividing the total cost by number of units produced. Output Costing is used in industries like
Cement, Cigarettes, Pencils, Quarries etc.
(d) Multiple Costing: This method of costing means combination of two or more methods of costing
like operation costing and output costing. Under this method the cost of different sections of production
are combined after finding out the cost of each and every part manufactured. This method of costing is
suitable for the industries manufacturing motor cars, engines, aircraft, tractors, etc.
II. TECHNIQUES OF COSTING
Costing is the technique and process useful to allocation of expenditure, cost ascertainment and cost
control. In order to fulfil the needs of the management it supplies necessary information to the
management. The following are the various techniques of costing:
(a) Uniform Costing
(b) Marginal Costing
(c) Standard Costing
(d) Historical Costing
(e) Absorption Costing
(a) Uniform Costing: Uniform Costing is not a distinct method of costing. In fact when several
undertakings start using the same costing principles and! or practices, they are said to be following uniform
costing. The basic idea behind uniform costing is that the different firms in an industry should adopt a
common method of costing and apply uniformly the same principles and techniques for better cost
comparison and common good.
(b) Marginal Costing: The C. I. M. A. London defines Marginal costing as "a technique of costing
which aims at ascertaining marginal costs, determining the effects of changes in costs, volume, price etc.
on the Company's profitability, stability etc. and furnishing the relevant data to the management for
enabling it to take various management decisions by segregating total costs into variable and fixed costs."
Cost - Methods, Techniques of Cost Accounting and Classification of Cost 307

(c) Standard Costing: Standard Costing is a technique of cost accounting which compares the
standard cost of each product or service with actual cost to determine the efficiency of the operation, so
that any remedial action may be taken immediately.
(d) Historical Costing: Historical costing is the ascertainment and recording of actual costs when, or
after, they have been incurred and was one of the first stages in the growth of the Cost Accountant's work.
Actual costs refer to material cost, labour cost and overhead cost.
(e) Absorption Costing: Absorption Costing is also termed as Full Costing (or) Orthodox Costing.
It is the technique that takes into account charging of all costs both variable and fixed costs to operalion
processed or products or services. .

III. CLASSIFICATION OF COST

Classification is the process of grouping costs according to their common characteristics or features.
There are various methods of classifying costs on the basis of requirements.
The following are the important bases on which costs are classified:
(a) On the basis of Nature (or) Elements.
(b) On the basis of Function.
(c) On the basis of Variability.
(d) On the basis of Normality.
(e) On the basis of Controllability and Decision Making.
The following chart can explain further the classifications cost:

Classification of Cost
On the basis of

Nature (or) Elements Function Variability Normality

1
(a) Material Cost (a)
1
Production Cost
1
(a) Fixed Cost
1
(a) Normal Cost
(b) Labour Cost (b) Administration Cost (b) Variable Cost (b) Abnormal Cost
(c) Other Expenses (c) Selling Cost (c) Semi-Variable Cost
(d) Distribution Cost (or) Semi-Fixed Cost

Decision Making & Controllability

l
(a) Controllable Cost
(b) Uncontrollable Cost
(c) Sunk Cost
(d) Opportunity Cost
(e) Replacement Cost
(0 Conversion Cost
308 A Textbook of Financial Cost and Management Accounting

(1) On the basis of Nature or Elements: One of the important classification cost is on the basis of
nature or elements. Based on elements, it is classified into Material Cost, Labour Cost and Other Expenses.
They can be further subdivided into Direct and Indirect Material Cost, Direct and Indirect Labour Cost and
Direct and Indirect Other Expenses.
(2) On the basis of Function: The classification of costs on the basis ofthe various function of a concern
is known as function-wise classification. Here there are four important functional divisions in the business
organization, viz.: (a) Production Cost (b) Administration Cost (c) Selling Cost and (d) Distribution Cost.
(3) On the basis of Variability: On the basis of variability with the volume of production Cost is
classified into Fixed Cost, Variable Cost and Semi Variable Cost; Fixed Costs are those costs incurred
which remain constant with the volume of production. Rent and rates of office and factory buildings are
examples of fixed cost.
Variable costs are those costs incurred directly with the volume of output. For example, cost of
materials and wages to workers are the expenses chargeable with direct proportion to the volume of
production.
Semi-Variable Costs are those costs incurred, partly fixed and partly variable, with the volume of
production. Accordingly, it has both fixed and variable features. For example, depreciations and ~aintenance
cost of plant and machinery.
(4) On the basis of Normality: Costs are classified into normal costs and abnormal costs on the basis
of normality features. Normal costs are those incurred normally within the target output or fixed plan.
(5) On the basis of Controllability and Decision Making: Based on the managerial decision making
and controllability the classifications are as follows: (a) Controllable Cost; (b) Uncontrollable Cost; (c) Sunk
Cost; (d) Opportunity Cost; (e) Replacement Cost; and (0 Conversion Cost.
(a) Controllable Costs: Controllable Costs are the costs which can be influenced by the action
of a specified number of an undertaking. Controllable Costs incurred in a particular
responsibility centre can be influenced by the action of the executive heading that
responsibility centre. For example, direct materials and indirect materials.
(b) Uncontrollable Costs: Uncontrollable Costs are those costs which cannot be influenced by
the action of a specified number of an undertaking. In fact, no cost is controllable, it is only
in relation to a particular individual that may specify a particular cost to either controllable
or non-controllable. For example, rent and rates.
(c) Sunk Cost: These are historical costs which were incurred in the past and are not relevant
to the particular decision making problem being considered. While considering the
replacement of a plant, the depreciated book-value of the old asset is irrelevant as the amount
is a sunk cost which is to be written-off at the time of replacement. Unlike incremental or
decremental costs, sunk costs are not affected by increase or decrease of volume. Example
of sunk cost include dedicated fixed assets, development cost already incurred.
(d) Opportunity Cost: Opportunity costs mean the costs offorgoing or giving up an opportunity.
It is the notional value of going without the next best use of time, effort and money. These
indicate the income or potential benefits sacrificed because a certain course of action has
been taken. An example of opportunity costs is the market value forgone or sacrificed when
an old machine is being used.
(e) Replacement Cost: Such expenses may be incurred due to factors like change in method of
production, an addition or alteration in the factory building, change in flow of production
Cost - Methods. Techniques of Cost Accounting and Classification of Cost 309

etc. All such expenses are treated as production overheads; when amount of such expenses
is large, it may be spread over a period of time.
if) Conversion Cost: Conversion Costs are those costs incurred while converting materials
into semi-finished or finished goods. It is the aggregate of direct wages, direct expenses
and overhead costs of converting raw materials into finished products.
QUESTIONS
1. What are theimportant methods of Costing? Describe each of them briefly.
2. What are the important techniques of costing?
3. What method of costing would you recommend for the following industries? Give reasons.
(a) Ship Building
(b) Ready-made Garment
(c) Sugar Industries
(d) Hospitals
(e) Cigarettes
(f) Motor Cars Manufacture.
4. Describe the different classification of cost in detail.
5. What are the important basic requisites for classification of cost? Explain them briefly.
6. Write short notes on :
(a) Uniform Costing
(b) Historical Costing
(c) Marginal Costing
(d) Standard Costing
(e) Sunk Costing
(f) Standard Costing.
7. What are the differences between controllable costs and uncontrollable costs?

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